Question

P13-3 Hill Industries had sales in 2016 of $6,800,000 and gross profi t of $1,100,000.
Management is considering two alternative budget plans to increase its gross profi t
in 2017.
Plan A would increase the selling price per unit from $8.00 to $8.40. Sales volume
would decrease by 10% from its 2016 level. Plan B would decrease the selling price per
unit by $0.50. The marketing department expects that the sales volume would increase by
100,000 units.
At the end of 2016, Hill has 40,000 units of inventory on hand. If Plan A is accepted,
the 2017 ending inventory should be equal to 5% of the 2017 sales. If Plan B is accepted,
the ending inventory should be equal to 60,000 units. Each unit produced will cost $1.80
in direct labor, $1.40 in direct materials, and $1.20 in variable overhead. The fixed overhead
for 2017 should be $1,895,000.
Instructions
(a) Prepare a sales budget for 2017 under each plan.
(b) Prepare a production budget for 2017 under each plan.
(c) Compute the production cost per unit under each plan. Why is the cost per unit different
for each of the two plans? (Round to two decimals.)
(d) Which plan should be accepted? (Hint: Compute the gross profit under each plan.)

Answer 1

Solution Sales Revenue in Year 2016 Selling price per unit (Year 2016) Sales units (Year 2016) ($6,800,000 / $8.00) $6,800,000 $8.00 850,000 units Budgeted selling price per unit under Plan A Budgeted sales units under Plan A (850,000 x (100-10)%) $8.40 765,000 units Budgeted selling price per unit under Plan B ($8.00 - $0.50) Budgeted sales units under Plan B (850,000 + 100,000) $7.50 950,000 units Beginning inventory Budgeted ending inventory under Plan A (765,000 x 5%) Budgeted ending inventory under Plan B 40,000 units 38,250 units 60,000 units Variable cost per unit ($1.80 +$1.40 +$1.20) Budgeted fixed overhead cost (Year 2017) $4.40 $1,895,000 Required (a) : Sales budget under each Plan HILL INDUSTRIES Sales Budget For the Year 2017 Expected Unit Sales Unit Selling price Total Sales Plan A 765,000 $8.401 $6,426,000 Plan B 950,000 $7.50 $7,125,000 Requirement (b): Production budget for 2017 under each plan HILL INDUSTRIES Production Budget For the Year 2017 Expected Unit Sales Add: Budgeted ending inventory units Total needs Less: Beginning inventory units Budgeted production units Plan A 765,000 38,250 803,250 40.000 763,250 Plan B 950.000 60,000 1,010,000 40,000 970,000 Requirement (c): Production cost per unit under each plan Plan A Plan B 3,358,300 Variable cost - Plan A ($4.40 x 763,250) - Plan B ($4.40 x 970,000) Fixed overhead cost Total cost Budgeted production units Production cost per unit 1 5 1.895,000 ,253,300 763,250 6.88 4,268,000 1,895,000 6,163,000 970,000 6.35 The cost per unit for each of the two plans is different due to the fixed overhead cost. Under Plan A, the fixed overhead cost applied per unit is higher as compared to the Plan B. Requirement (d): Computation of Gross profit under each plan Plan A $6,426,000 Sales revenue Plan B $7,125,000 (3,366,000) Less: Variable cost - Plan A ($4.40 x 765,000) - Plan B ($4.40 x 950,000) Less: Fixed overhead cost Gross profit (1,895,000) 1,165,000 (4,180,000) (1,895,000) 1,050,000 Plan A $1,165,000 Plan B $1,050,000 Gross profit Under Plan A, the Gross profit is higher. Hence Plan A should be accepted.